Hedge fund firm rehired by state for pension advice

Share via e-mail

As the Massachusetts state pension fund overhauls the way it invests in hedge funds, it has rehired a money management firm the fund once dropped — this time only to offer advice about funds run by others.

The state’s Pension Reserves Investment Trust has tapped Arden Asset Management of New York as its new hedge fund consultant. Arden, which manages $6.3 billion by investing money in other hedge funds, was one of many firms ensnared in the Bernard Madoff scandal. The Madoff bankruptcy trustee sued Arden to recover $43.4 million in a case that remains unresolved.

Now Arden will be paid $750,000 a year to scour its database for top hedge funds, helping the state manage about 9 percent of its $59.8 billion pension fund. The firm was chosen over 16 other competitors for a three-year contract.

“It’s a great value to us and I think it’s unique,” said Michael Trotsky, the pension fund’s executive director.

The state expects to save $40 million a year by making most of its hedge fund calls internally, with a bit of outside advice from Arden.

Over the past three years, the state has moved away from its old strategy of investing through Arden and other similar firms that picked a group of hedge funds on its behalf. Those so-called “fund-of-funds” firms were once considered the best way to gain access to sought-after hedge funds.

But Trotsky, a former hedge fund executive himself, believed it would be better and cheaper to go direct — and get to know the hedge fund managers who actually oversee $5.8 billion of pension fund assets.

The state has slashed its exposure from 237 hedge funds in the fund-of-funds strategy to 23 direct investments. It has kept a relationship with just one intermediary firm, Pacific Alternative Asset Management Co., which invests in newer, emerging hedge funds.

Massachusetts was one of the first major pension funds to move away from the intermediary firms. The financial crisis and the Madoff scandal laid bare the risks of those firms and the fact that many did not provide the kind of scrutiny or monitoring investors expected.

Arden was dropped as a manager by the state in 2011, along with the other intermediary firms. But it was retained to help the pension fund make its transition to investments in individual hedge funds.

Arden did not do business directly with Madoff, but it invested with two firms that in turn handed most of their client money to him. Trotsky said the pension board reviewed the matter and believes Arden detected the problem early, getting out of funds that did business with Madoff by 2002 — six years before the swindle came to light.

Arden allegedly made money for its clients on Madoff. The firm was sued in 2012 for $43.4 million by the bankruptcy trustee charged with recouping money for Madoff’s victims. A spokesman for Arden declined to comment because the litigation is ongoing.

“We think Arden was ahead of the curve” in realizing there was a problem with Madoff, Trotsky said. “There will always be crooks and criminals in any industry, and probably particularly in the financial industry, where there’s so much money to be made.’’

Arden has been a popular investment choice among many firms and pension funds. Managed account clients of Boston mutual fund giant Fidelity Investments have more than $1 billion with the firm.

Trotsky acknowledged that Madoff was a dark chapter of Wall Street history. “Many people, including us, were fooled by him. It’s one of the reasons we changed the way we invest in hedge funds.’’

The state lost $12 million on Madoff through an investment in another fund-of-funds firm, Austin Capital Management. Other hedge fund implosions also hurt the pension fund’s holdings.

Those losses prompted Trotsky and state Treasurer Steve Grossman, chairman of the state pension fund, to rethink a system that left them exposed to so many hedge funds and unsure of what they owned.

“I feel very uncomfortable investing with any manager that I haven’t met one-on-one,’’ Trotsky said. “We’ve made great strides in trying to concentrate our bets, get to know who we’re investing with, and be more staff-driven.”

He said the new approach is performing well so far. The pension fund has earned 3.2 percent from its hedge fund portfolio so far this year, compared with a 1 percent gain for a widely followed hedge fund index. The portfolio has gained 9.4 percent over the past 11 months, compared with a 6.5 percent advance for the index.